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Last week, I talked about the closing costs home buyers need to be aware of when purchasing a property. These included lender fees such as loan origination, underwriting, and paying points (aka “discount points”), if applicable. It might help to know exactly what these points are and how they work before you decide if the extra expense is worth it.
How Discount Points Work
Basically, when you pay “points” up front, this lowers your interest rate. While you bring more to the table at closing time, it saves you money in interest payments over the life of your loan. Each “point” costs approximately 1% of your loan’s value. In other words, if you borrow $350,000 to pay for your Inland Empire home, it costs you $3500 upfront to bring your interest rate down by 0.25%. That is in addition to your other closing costs and your down payment.
As of the writing of this post, Freddie Mac puts current interest rates for a 30-year fixed-rate loan at 6.33% for those with excellent credit. On that $350,000 mortgage loan, paying one point saves you $57 per month. Paying two points saves you $117. But then you also must come up with another $7000 at closing in order to pay 0.5% less interest. At this point, you might be thinking to yourself “is it worth paying this extra upfront cost?”.
Are Paying Points Worth It?
Short answer? It depends. If your credit score does not qualify you for the best interest rates, it may be worthwhile. Keep in mind, though, that it takes anywhere from five to ten years to recoup that extra cost. So, if you plan on only staying in your home for a few years before selling it, that money might be better spent towards your down payment or saved for your household emergency fund instead.
How Does This Affect My Taxes?
Generally, you can deduct the interest you pay on your mortgage throughout the year. Since discount points serve as prepaid interest, it also usually falls in the “tax-deductible” category. However, the IRS only allows this deduction on the first $750,000 borrowed for your mortgage. So, if you borrow $800,000 for your mortgage and pay for one point (1% or $80,000), only $75,000 of your discount points paid will be tax deductible.
Discuss your options with your mortgage broker before you decide whether or not discount points work to your advantage. You may also want to talk to your tax advisor as well.
Muna Dionne, your Inland Empire specialist with Coldwell Banker Realty
